It is hard to get excited after looking at Luye Pharma Group's (HKG:2186) recent performance, when its stock has declined 29% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Luye Pharma Group's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Luye Pharma Group

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Luye Pharma Group is:

16% = CN¥1.5b ÷ CN¥9.4b (Based on the trailing twelve months to December 2019).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.16 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Luye Pharma Group's Earnings Growth And 16% ROE

To begin with, Luye Pharma Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Luye Pharma Group's decent 18% net income growth seen over the past five years.

We then compared Luye Pharma Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 15% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Luye Pharma Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Luye Pharma Group Making Efficient Use Of Its Profits?

Luye Pharma Group's three-year median payout ratio to shareholders is 25% (implying that it retains 75% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Luye Pharma Group is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 17% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

On the whole, we feel that Luye Pharma Group's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.